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Building the perfect portfolio: the 10 timeless rules of investing

Investor

Alan Greenspan. Photo: Bloomberg

We are all vulnerable to the herd mentality. Its why booms become ‘boomier’ and dips become caverns. In other aspects of our lives having core principles or value systems can help inform our choices and temper emotive or irrational behaviour. Investing should be no different.

The following are some tried and tested ‘rules of thumb’ that should help both novice and seasoned investors alike.

1 Take the rough with the smooth

The largest gains tend to occur during periods of extreme volatility and often follow large sell-offs. During these episodes inexperienced investors panic sell or look to play the market. As the table below shows, if you were out of the market, even for brief spells, you might have missed out on these gains or returned a material loss. Successful investing requires taking the rough with the smooth rather than trying to play the market in search of a quick profit.

2 Drown out the noise

Most of the financial industry is incentivised to get investors to do something and many investment houses and brokerage firms profit when investors buy or sell shares. This leads to a lot of noise in the market, which is a poor basis for investment decisions.

3 Time in the market, not timing the market

€1m invested in a moderate growth multi-asset portfolio delivering an average 7.4pc per annum between 1990 and January 2018 – a period that included the dotcom bubble and global financial crisis – would now be worth almost €7m. That’s the power of compounding.

4 Geopolitics (often) matters less than we think

It is easy to focus on what can go wrong in the world and extrapolate these geopolitical events into investment returns. Yet, over time, geopolitical shocks (outside of world wars) tend to exhibit little or no relationship to returns.

5 Build a robust portfolio

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Diversification is probably the most commonly quoted and most commonly ignored piece of investment advice. In the lead-up to the global financial crisis too many people were holding too much property and bank stocks, and often with an overexposure to their own country. As we now know, that strategy did not work well.

6 Don’t follow the herd

“Irrational exuberance” was a phrase championed by former Federal Reserve Chairman Alan Greenspan(pictured) to explain investor’s behaviour in the mid-to-late 1990s. Although it took several years for the bubble to burst, the phrase epitomises the tendency of investors to get most bullish just before a collapse.

7 Invest counter cyclically

One of the few constants in investing is that all economies are cyclical – that is, they expand and then contract. By focusing on the cycle, investors can determine the prospect for different assets and markets at the different stages, and importantly can avoid taking on excessive risk when the economy is showing signs of overheating just before a recession.

8 Price is what you pay, value is what you get

Overpaying for investments is a common mistake. We saw it in the housing bubble in the run up to the financial crisis, the tech bubble at the end of the 1990s and the tulip mania of the 16th century.

Getting carried away is part of human nature. Warren Buffett says, “price is what you pay, value is what you get”. Always consider the intrinsic value of an investment before putting your hard-earned capital at risk.

9 Don’t let your emotions cloud your judgement

Emotion is dangerous when investing. The most successful investors take profits and rebalance their portfolio regularly.

Our experience shows that failing to take profits can result in ‘risk drift’ in portfolios and can lead to investors being overexposed to a market correction.

10 Don’t chase performance

A common failing of investors is chasing performance by buying more of an asset, sector or stock that has performed the best in the most recent time period. A large body of evidence tells us that assets that attract the largest amount of inflows subsequently underperform and are best avoided.

Eoin Corcoran is head of portfolio construction in Davy Private Clients